The Immortal Ponzi

From time to time, Delia Fernandez will author a guest post on our blog. [Disclosure:  There is no express or implied relationship or financial ties between Delia's practice and Tredway, Lumsdaine & Doyle, LLP.]

In the midst of last week’s subprime crisis, a client called to tell me a sad but familiar story. A friend of his in California had just lost $450,000 in what he thought was a currency trading account, but which turned out to be a Ponzi scheme. Worse yet, he talked his friends and family into investing with this guy, so all together they were out about $2 million.

The friend made his decision to invest with the Alabama-based advisor based only on some telephone conversations with the man. He never met him in person, and yet he sent him most of his money to invest. And like all victims of well-run Ponzi schemes, he didn’t initially sense there was a problem. Indeed, he received monthly income payments for a couple of years. But then one day they stopped. That’s when he discovered that the Alabama man had skipped town, leaving him and his friends to sort things out with the authorities.

The kicker to the story? The victim was an attorney.

I was thinking about this case when I picked up this week’s Barron’s and read about another Ponzi scheme promulgated by a Portland, Oregon advisor named Wesley Rhodes Jr. (Read the full story here). Unlike the Alabama crook, Rhodes was a very public figure; he ran magazine ads for his investment firm, sat on charity boards and even had a radio show. He enjoyed meeting and socializing with clients, and most felt he was a family friend. Unfortunately, authorities estimate that over the past 15 years that Rhodes has bilked investors out of $24.6 million or more, spending it on fast cars and sports memorabilia.

Like the victim of the Alabama crook, Rhodes’ victims were educated professionals, making it all the more frustrating a story (one of them was even a financial planner!). They set up a blog to vent about their losses, so I read it to see if I could find some clues to help people avoid this kind of scam. A few things quickly jumped out at me, so I thought I’d pass them along as tips to follow before choosing an advisor:

Be sure your funds are in an account with an established brokerage firm where you can confirm the existence of your investments and account balances. This is critical. Rhodes got control of his victims’ money by offering them a “side” account, what he called an Investment Administrative Account, that he said was better than a mutual fund or other investment that would be held at a brokerage firm. At one point he was even offering these accounts while employed by an actual brokerage firm. Naturally, those side accounts were controlled only by him and could only be verified through him, putting his victims in the dark about their money – which is right where he wanted them. The Alabama swindler separated my client’s friend from his money the same way.

Check your advisor’s record with regulators. Turns out Rhodes had been in trouble with Oregon regulators since 2000 for failing to register as an advisor, selling unregistered securities, commingling client funds and failing to disclose material information. If any of the victims had simply called the appropriate regulator first, they would have found plenty of warning signs. All registered investment advisors are required to give you their form ADV before any engagement, and you can verify their registration and check their record as well as any broker’s record with the SEC or California’s Department of Corporations.

Be wary of vague account statements. Rhodes claimed to run three legitimate investment advisory firms, (only one was actually registered), but his account statements were increasingly unprofessional. One victim complained that typed statements of their actual holdings had become vague, mentioning only “stocks,” “bonds,” “securities” and “convertible debentures” as holdings, without specific company names. In fact, it was a phony 1099 that didn’t look right to one of Rhodes’ clients that led to the recent investigation and conviction.

Rhodes’ victims and my client’s friend failed to diversify their holdings, which is just common sense. Don’t put all of your money into one currency trading account, or one side account, or one stock. That’s too much risk in one place.

Delia Fernandez, MBA, CFP®
Fernandez Financial Advisory, LLC
delia@fernandezllc.com
562-594-4454

Comments

[Cate Garrison]

I'd just like to offer a quick correction to your useful advice regarding con men such as Wes Rhodes. You say his investors "set up a blog." In fact,(although I do allow outside comments that don't always reflect my opinion) the blog is mine--the work of a single blogger--not a joint effort. Though most of Rhodes' ex-investors (or at least those I know, or know of) seem to approve and follow my "musings," they aren't responsible for writing them.
Secondly, my husband and I used Mr. Rhodes as our money manager LONG before there were any actions against him by the state. We engaged him in 1988 or 1989, ten years before that 1999 action. Unfortunately, neither Mr. Rhodes NOR the state made us aware of it. In 1999, it wasn't as easy as it is now to find information on the 'net (and even now, it's not straightforward for a layperson).
Thirdly, we did of course ask to see details of where our holdings were, and Mr. Rhodes presented us with such details when we did so. I do say in the blog that, over the years, his quarterly statements to us became increasingly vague (please remember that I wrote ALL of the blog) but that doesn't mean we didn't ask, and weren't shown, details of our so-called investments during office encounters. And Mr. Rhodes provided my husband's practise with immense details when my husband retired--details that clearly convinced more financially gifted people than ourselves. Unfortunately, those details were lies.
Fourthly, there was no point at which we realized that all Mr Rhodes' accounts were NOT overseen by a brokerage or other company. The term "side account," though it has been used often by the authorities in this and other cases, is misleading. We were under the impression (backed up by documentation and Mr. Rhodes own words) that the account in which the BULK of our funds were held was the major account. And we received 1099s from him every year, and paid tax on "interest" or "dividends."
I'm not in any way trying to lessen the impact of your good advice. I only want to stress that conmen are very good at what they do. In our case, Mr Rhodes pulled the wool over our eyes for twenty long years; our portfolio grew (we thought) slowly and steadily, managed (we thought) under the umbrella of a larger finance house. Other people, savvier than ourselves, also asked questions and obtained plausible answers. Mr. Rhodes peppered his office walls with diplomas, certificates and attestations of military valor (in the Marines). He wrote for reputable newspapers and in house medical magazines and gave a daily radio broadcast. He was a very good conman. There is no easy answer. We, and others who were with him in his sad affair, did all the things you suggest and more, believe me.